What’s the first thing you think of when you hear ‘foreign exchange?’ - for most, I would say it is the rate. It’s often the first thing (and sometimes the only thing) people think of and we don’t blame them. After all, the rate is an integral part of the foreign exchange market. It needs to exist in order to have foreign exchange in first place. However, we believe that there is more to the industry and the rate is just one piece of the puzzle. We also want to pose the question, is getting the best rate necessarily giving you best deal? There are many different factors to the foreign exchange market a business needs to consider.
In this webinar, we will look at some different factors that everyone in business should be addressing, but up to 80% of UK businesses ignore. We will also try to demonstrate the importance and relevance it can have in multiple areas of a business and how a simple change can actually have a big effect on the wider business.
Factors of foreign exchange
We mentioned there are many other factors to the foreign exchange market that businesses need to consider. Some of these may not seem as though they are linked to foreign exchange, but hopefully, we will be able to demonstrate how they are all linked to one another - so what are some of these factors?
- Cash flow and cash flow forecasting
- Managing profit margins
- Managing expenditure and credit control
- Managing payments
- and your currency exposure, to name but a few
Why are we mentioning some of these, surely they seem obvious to anyone who has worked in a business or run a business or is currently running a business? We believe that actually the last one, currency exposure, links all of them together and yet is the first one to “go under the radar” and be ignored. I want to cover a couple of the points from the list and demonstrate what can be a simple change but one that could really transform the efficiency of any SME.
Are you exposed?
Imagine, if you will, that you are a local business owner who runs a business supplying specialist building parts for electricians, plumbers and carpenters. You receive an order from a building firm for a very specific part they need to complete the plumbing on their latest project. You know that this particular part is manufactured in Spain and therefore need to get it delivered to your warehouse in the UK. Your supplier in Spain invoices you in Euros, you invoice your client in Sterling.
Without realising it, you are now exposed to currency fluctuations. If, for example, the plumbing part cost 600 Euros, would you simply invoice your client £600, or report the purchase in Sterling? Of course not. It is also very possible that the bank just does everything for you and it lands in your business account in Sterling - whilst this might seem efficient, it is usually a more expensive because of bank charges. Now imagine that this is not just one part you are ordering, but multiple parts, from various suppliers, in many different currencies and numerous times a month. What this means for your business is that any fluctuations in currency when exposed leaves a potential for a loss of profit and lots of uncertainty.
A swing in the exchange rate could negatively affect the purchasing power you have and could mean that you end up spending more to get the same product(s). This could have a detrimental effect on your cash flow. If this happens for multiple products/multiple orders, as a business you may now have multiple exposures and not even realise it.
What happens if one of the business’ main clients are in France and they pay for your products in Euros? Again, without possibly realising it, and completely unintentionally, your business is now exposed. The point I am trying to make is that almost everyone, business or not, has at one point been exposed (to foreign currencies).
We’re all going on a summer holiday
Let’s think about this in a slightly different way, and look at something we do so naturally with our personal finances. Why, before virtually every holiday, does everyone always say “I need to get my Euros” or, “I need to get my dollars - I don’t want to leave it until I get to the airport”. We do not think twice about getting currency out before we go away on holiday but why do we do this? And more importantly, why don’t 80% of UK businesses with foreign exchange exposure do this when they think about their business?
In personal finance, as well as business finance the rate is very important - most people probably do it so that they do not receive a bad exchange rate when they get to the airport. This is a form of planning in order to maximise how far your money will go abroad but essentially it is probably one of the main reasons to “get your Euros” before you go away. We all know this scenario, don’t we? So why do we hesitate to do the same for our business? Could we lock in a rate at the start of a contract to ensure we are getting a rate that would work for our business, one that is tailored to our needs and one that we have planned for? Perhaps the rate is not the only factor when getting our Euros out before we go on holiday and perhaps the rate is not the most important thing when a business sets out in the foreign exchange market. Of course, we realise it is important, but a business needs to consider things such as certainty in their overheads, and a locked in rate could help with that.
Budgeting is another reason - most people I know who are travelling abroad, like to take almost all of their money out beforehand in order to try and budget, you know exactly how much money you have to spend each day. This is almost second nature to everyone when going away, and combined with getting the best rate forms a very basic budget for your holiday. Your business is the same - often you need to budget for various departments - research and development, marketing, IT, operational costs, staff. Many costs that arise can be unexpected, but some are predictable and utilising something such as a forward contract, for example, would help with budgeting as you know the amount that you are receiving at each interval.
Another major factor is peace of mind - seems strange but most people feel like they can’t relax until they have their currency sorted. It’s one less thing to think about. It provides a level of certainty for the upcoming holiday and helps you focus on enjoying yourself as you have planned ahead and the same applies to your business. Forward contracts, or flexible forward contracts, provide peace of mind, an accurate representation of what your business’ finances could look like when you are exposed to a currency whilst also securing a good rate for your currency. They can also guarantee a rate for a future date, take advantage of favourable rates, protect your forecast costs or revenue and lock in bottom line profits.
These different factors, budgeting and peace of mind, are so common when going away, they are so ingrained when planning a holiday that everyone does it as second nature. This is actually an example of managing currency exposure and yet many businesses will not do this. Why does almost everyone do it for their personal finances, and so few do it for their business finances?
Let’s consider an example to show just how significant foreign exchange risk can be to one of the biggest and most famous startups in the world: Uber. Uber is, of course, a huge entity operating all over the world. As such, a huge portion of their revenue will be in other currencies and will need to be repatriated back to the US and exchanged into US Dollars. Currency volatility will, of course, have a huge effect on their actual take-home revenue.
Uber’s revenue in 2017 was $7.5 billion. For 2017, the disparity between the top end and bottom end of the Pound/Dollar rate was 11% across the year whilst the difference for the Euro/Dollar rate was 14%. This means that the potential difference in revenue was $825 million for Pound/Dollar and $1.05 billion for Euro/Dollar. These are only three currencies mentioned in a multinational company.
Whether you are a large-scale entity or a small startup hoping to reach the size of Uber, it’s crucial to manage FX all the same.
Lead by example: Uber
If, (and almost always in my case), you run out of money on holiday, a trip to the cash point is almost inevitable. We have all done it before and we almost always do two things automatically: (1) take out money in bulk, and (2) when the question of ‘do you want to pay in Sterling or the local currency?’ arises, make sure the foreign bank charges you in your home currency (your reporting currency) - what does this mean for a business making its first foray into foreign markets?
One of the factors mentioned earlier was managing payments so let's have a look at bulk payments - why do we only take out large amounts when on holiday? Everyone has done it and almost no one takes out 10 Euros at a time for example. One of the main reasons is because it is inefficient to keep doing this and will be unnecessarily expensive doing this multiple times due to bank charges. Capital Economics estimates that individuals and businesses are being charged nearly £6bn a year in fees without realising it. It is very easy to see a business letting the bank convert all the foreign currency when making bulk payments to overseas suppliers but we would never let that happen to our personal finances so why would we let it happen to our business?
Various tools can be used to manage this business risk such as forward contracts, rate agreements, or a more efficient hedging strategy, which would allow your business to reduce or manage the exposure in a controllable and predictable manner.
Being invoiced in different currencies - This exposure risk when you are on holiday is much higher for a business when being invoiced in a foreign currency. It is calculated that the average Brit will pay more than £5,000 in hidden fees over their lifetime, with people who retire abroad or own holiday homes paying far more. When inflation is factored in over a lifetime of travel, that figure rises to nearly £17,000. A snapshot of foreign exchange fees from a variety of suppliers shows that banks offer some of the worst rates. This is important because many businesses will routinely use their banks to complete transactions in foreign currencies.
It is, however, manageable, and with a clear and define hedging strategy this risk can be effectively mitigated.
Consult a specialist
Firstly, apologies for the cheesy holiday analogy, but we think it serves as a good example of where in our personal lives we would never dream of letting ourselves get caught out by currency exposure and yet for many businesses it is not high on their priority list.
I could go on and explain how currency exposure could negatively affect profit margins, expenditure and other areas of your business but I don’t think I need to - you can see what I am trying to get at. What I am also trying to say is that we specialise in foreign exchange, have done for 18 years and have just won a British Banking award for it. Who would you go to to get your accounts done? An accountant. Who would you go to for legal advice? A lawyer. Who would you go to for medical advice? A doctor. So why wouldn’t you go to a foreign exchange specialist when you have any currency exposure? We do it in our personal lives when going abroad, we should be doing it as a business. Many businesses just let the bank deal with their currency and this is not the most efficient way to do this - when you go on holiday you get your currency from a specialist currency exchange, not from your bank, so why would you do the same for your business?
Foreign exchange is a very overlooked overhead - it is a lot more than just a transaction. It should be a part of the financial department of a business and it should be managed, not just mitigated. In 2016 Santander revealed to the Guardian that 10% of its global profit came from international money transfers and they were revealed to be 6 times more expensive than a foreign exchange specialist when transferring money from the UK to Spain. Whilst banks may have got more in touch with the foreign exchange market, they are still behind specialist currency providers. We realise we have to be better and more efficient than the banks, if we weren’t then our industry wouldn’t exist and yet it does, so we must be doing something right.
I have tried to demonstrate how businesses can learn something from our personal finances, how things we do automatically can apply to running a business. If you would like to speak with us about anything mentioned in this webinar, any of the factors mentioned earlier or FX in general, then you could sign up to one of our Currency Clinics by using the link on the screen. They are free phone consultations with one of our experts who will answer all your FX-related questions.
Posted in Business Resources on Jun 5 2018